Softrax Revenue Recognition Blog

Revenue Recognition - ASC 606 Roundup: 1/7/2019

This week’s entry will run through recent notable and instructive 10-Q filings that had frequent references to ASC 606. Additionally, we also share a high value ASC 606 exchange between a company and an analyst during a recent earnings call and a few notable articles.

To quickly identify ASC 606 information in the below links, click on the link, hit Control + F, enter the text “606”, “2014-09”, or “ASC” and go to your search results.

Filings

Our thoughts: In the “Revenue Recognition” section spanning pages 9 through 12 is a solid qualitative discussion of the company’s revenue recognition policies. It discusses the company’s different performance obligations, timing of revenue recognition for each type of performance obligation, and how ASC 606 impacted these areas.

Of note is the section “Allocation of the Transaction Price for Contracts that have Multiple Performance Obligations” on the bottom of page 11 and top of page 12. Within this section, the company identifies how it arrives at standalone selling prices for the products and services it sells. It explains that certain products do not have standalone selling prices identified from past transactions or other observable evidence thus requiring the use of the residual approach to arrive at SSPs for such products. While this is qualitatively presented, quantitative information to support its use of the residual approach is not provided in this section.

Earnings Calls

Our thoughts: The below exchange between an analyst and the company’s CFO highlights how interactions on earnings calls are becoming more pointed as it relates to ASC 606.

Paul Treiber - RBC Capital Markets:“Just lastly on ESS, enterprise software, how do we think about the seasonality of revenue going into Q4 in light of 606?”

Steve Capelli - CFO and COO:“Well, Q4 was our biggest perpetual license quarter last year. So, you have a little bit of a change there. And I would still expect a sequential growth from Q3. I won't tell you whether it'll be the same rate as we've done in Q2 -- Q1 to Q2 and Q2 to Q3 but I will still expect an uptick.”

Paul Treiber - RBC Capital Markets:“And just so I fully understand, even with 606, there’s still some license revenue that you would take on upfront basis?”

Steve Capelli - CFO and COO: “Yes. So, how it works is as follows. As long as we have delivered all of the services at the time, we can take the revenue. Let me give you an example. So, you could have a situation where a singular product is being sold as opposed to the suite. And obviously in that space we have a product Secusmart, which is different functionality than our normal UEM. So, we do have some components that will have the immediacy of revenue.”

Our thoughts: The below exchange is a multi-part question an analyst puts forward regarding ASC 606’s impacts. What’s notable is the analyst specifically asks about expected backlog under ASC 606. This is a metric that companies need to have readily available during calls, or at least have a canned response to handle, as it’s coming up on earnings calls per our review.

Additionally, the below illustrates that ASC 606 incurs a level of due diligence and work for companies regardless of whether its impacts will be material or not.

Sanjit Singh- Morgan Stanley:“So, Jim, I don't think we've moved to 606 yet. So, wondering if you could just sort of review just from a high level, what the major impacts you expect on the various revenue lines and on the cost side, how we should think about that? You can provide a framework of that. And secondly in terms of the backlog, that’ a metric that software companies have increasingly reported. I was wondering if you could give us any color on where sort of software backlog stands today as we start to think about 606 going into next year.”

Jim Frankola - CFO:“Okay. So, 606, we’ve completed our historical work for 606. It doesn't have a big impact on our software revenue, at least for the past year or two. It does accelerate services revenue into the earlier periods. So, let’s call for software revenue, it will be plus or minus one, two, three percentage points we think impact for services, it might be between 5% or 10% of either drag or tailwind, depending on what period you're looking at. And once again, we'll provide all the details and the bridges once we close Q4.So, I don't think 606 is going to have a big impact. And by way more broadly, the way we recognize the revenue the fact that most of our software is at its core open source, means that in general, most of our software offerings have revenue with very little upfront recognition. So, that is one reason why there's not much impact on 606. Regarding backlog, too soon. We're not as focused on it right now as we're closing the books and focusing on the merger. Let us get through the year and we'll look to what sort of disclosures at what level in a 606 world we’ll give you on backlog.”

Our thoughts: This earnings call transcript has 9 references to ASC 606 where 8 out of the 9 are part of the company’s opening comments. While that section is worth a read, our focus is on the 9th reference to ASC 606. Specifically, an analyst asks a multi-part question that includes inventory and the company’s expected revenue recognition under ASC 606 as follows:

Gary Mobley - Benchmark Company:“I did notice that you're showing the inventory item on the balance sheet, and it appears as though inventory is up about twofold year-over-year. Could you speak to that increase? And then as well, as you start to gather revenue from cloud-based delivery, would you expect any change in the way revenue is recognized from that? Thank you.”

Trac Pham - CFO:“So the first part of the question is, yes, we are reporting inventory levels, and that's to support the demand of hardware and the timing of when customers do need hardware. I missed the second part of your question.”

Gary Mobley - Benchmark Company:“So can you speak to the reason for the twofold increase in the inventory compared to this time last year and then as well, how delivery of cloud-based EDA tools may impact your revenue recognition, if at all?”

Trac Pham - CFO:“So it won't affect revenue recognition. Hardware has traditionally been recognized upon shipment, which is typically upfront. So we'll continue to see that under 606. And as I mentioned previously, the buildup in inventory is just a function of the growth in the hardware business.”

Articles

Our thoughts: If your company has warranty considerations for ASC 606, this article will hold value to read. It’s written from a unique, non-accounting, operational perspective that gives visibility into how other parts of companies affected by ASC 606 view its impacts. Two sections stand out as follows:

“Though it's mainly about revenue recognition, ASC 606 also forces manufacturers and retailers to separate product warranty from extended warranty, and account for each differently. But to get there, the FASB confuses the issue with new terminology and vague concepts.”

“What the next edition of ASC 606 needs is help from someone who works in the business -- someone who knows the difference between a product warranty and an extended warranty, someone who knows that extended warranties and service contracts are sold separately while product warranties are not, and someone who knows how to defer and recognize revenue using the straight-line method and/or as claims arise. It's not rocket science, but it is a science, and while warranty professionals know how it works, it's obvious from cases like this that the people writing these standards just don't get it.”

What level of risk are you willing to accept with your company’s ASC 606 adoption? What would the costs be to your company if it gets ASC 606 wrong? What would the costs be for you? We encourage you to visit http://www.softrax.com/contact-us for information on how SOFTRAX can help your company and you handle ASC 606.